Russia automotive

Russia's tentative revival

November 29th 2017 | Russia | Passenger vehicles | Multiple companies

Automakers are getting optimistic about Russia again, but they still need to tread carefully.

The auto market in Russia has been in nosedive since 2014, when the collapse in global oil prices and the imposition of international sanctions following Russia's intervention in Ukraine triggered a two-year recession in the country. By 2016, total vehicle sales were down to just half of their 2011 peak. In 2017, however, the market appears to have turned the corner, with sales up by 11% year on year in the first nine months. That in turn appears to have sparked an upturn in investment by foreign automakers such as Ford and Daimler.

In September this year, Ford Motor Co added 700 new jobs at its plant in Elabuga, Tatarstan, marking its first expansion in Russia for four years. Daimler, owner of the Mercedes-Benz brand, announced plans to open its first passenger vehicle facility in Russia in February. Other carmakers, including Skoda (part of Germany's Volkswagen) and Japan Mitsubishi are retooling to start production of new models.

The renewed interest in the Russian auto market has been driven by the country's economic recovery, as private consumption, investment and oil export revenues recover. With global oil prices edging above US$60 a barrel, the country's real GDP rose by 1.6% year-on-year in the first three quarters of 2017, up from 0.5% in the same period of 2016. The Economist Intelligence Unit expects Russia's economy to grow by 2% this year and its currency to stabilise against the US dollar. As a result, the car market is likely to grow by almost 12%, with the momentum continuing into 2018.

Buyer support

Buyers are also being lured in by government subsidies and loans. The main mechanism is a scrappage scheme, under which consumers can get discounts on the purchase of a new vehicle if they scrap their old vehicle. First introduced in 2014, it has been renewed on a regular basis ever since, and earlier this year, Russia said that it was planning to extend the scheme to trucks. The government has also allotted Rb10bn this year for car leasing and loans, to support customers in buying cars. Further market stimulus programmes came into effect in July, offering subsidies to families with two dependent children.

The automotive industry expects to sell nearly 60,000 additional vehicles owing to the new subsidies, while the loan and programmes will play a role in the sale of 750,000 vehicles (or around half the market). The incentives have been particularly beneficial for AvtoVAZ, one of the largest local automakers, which expects to return to profit next year after several years of financial problems. In the first eight months of 2017, the Russian automaker sold over 192,000 vehicles, an increase of almost 20% from a year earlier.

AvtoVAZ's biggest shareholder, France's Renault, has also benefited from the revival in demand, particularly for the sports utility vehicles (SUVs). In early 2017, SUVs became the best-selling category in the Russian market, beating B-class vehicles such as compact cars, with buyers valuing them not just for prestige reasons but also because they are robust enough to cope with Russia's often potholed roads. Renault accounts for 12% of the SUV market, which totalled 427,000 units in the first nine months of 2017.

Production trends

A similar pattern can be seen in production, which has recovered strongly this year. According to the Association of Russian Automakers (ARA), domestic production of passenger cars increased by 19% year on year in January-June, and output of trucks rose by almost 17% in the same time period. Again, the SUV segment is attracting particular interest. Skoda Auto plans to start production of its Kodiaq SUV at its plant in Nizhny Novgorod next year, while Mitsubishi Motors has resumed production of its Pajero Sport SUV at its plant near Moscow, adding 440 jobs in November.

Government support has also been instrumental here. More than Rb60bn (US$100m) was allotted in subsidies in 2017 to help domestic producers source more local content, while another Rb17.5bn will offset other production expenses. In addition, there are investor incentives; Daimler says local government incentives lay behind its decision to start Mercedes production in Russia. According to a report by PwC, a consulting firm, production capacity in Russia is expected to reach 3.3m units in the next five years, mainly on the back of three car plants, which include Daimler's plant in Moscow. Production in 2016 totalled just 1.3m units.

Not all the production incentives are positive ones, however. As part of its drive to build up the country's auto-parts suppliers, Russia has imposed a local-content requirement on automakers since 2005. These obliged foreign carmakers operating in Russia to source 30% of their components locally by late 2009. In 2010 the target was raised to 60% for 2015, and amendments in 2015 set new targets for 2020. Meanwhile Decree 166, passed in 2011, imposes import tariffs on foreign automakers that fail to produce at least 300,000 units a year in Russia. The weakness of the rouble has introduced another incentive to produce locally, by effectively raising the price of imports.

In driving up production, the government is not just focused on the local market. It is also aiming to triple car exports to US$4.9bn by 2025. Russia's major export markets are its neighbours in the Commonwealth of Independent States (CIS), the Middle East and emerging markets such as India. For automakers, these offer higher margins than local sales, reflecting the still-depressed state of Russian incomes. In the first nine months of 2017, Russia exported 33,000 vehicles, a 52% rise from a year earlier.

Cautious optimism

The recovery, then, is strong, but the question in Russia is always: how long can it last? Whether automakers remain confident will depend partly on global oil price movements and partly on the government's policies. We expect global oil price to soften slightly in 2018, to around US$59/barrel, with OPEC largely failing in its efforts to move the market higher. Trends in the global auto market will also keep oil demand largely static, as governments encourage consumers to buy more fuel-efficient vehicles. Subdued oil prices will dampen Russia's economic recovery and keep the rouble relatively weak.

As for Russia's political situation, international sanctions on Russia will probably stay in place until there is full implementation of the Minsk II agreement in Ukraine, which seems unlikely for now. On the plus side, with the Russian presidential election coming up next year, the Russian government will be careful to not engage in another conflict. Russia is also an ally of China, whose Belt and Road initiative is expected to pump in more money into industrial production in Russia. The FIFA World Cup is also around the corner, and the resulting infrastructure spending should boost vehicle sales.

We expect car sales to report a compound annual growth rate (CAGR) of 8.7% between 2018 and 2022, while commercial vehicle sales will rise by 6.9%. In the short term, however, the improvement in the auto industry's position will be marginal and the long-term outlook is heavily dependent on the government's production schemes and the new president's approach to business and investment. Though automakers such as Renault have said that they will focus on generating sales from Russia, Toyota has urged caution on over-optimism. Russia's recovery has just begun, but it will take some time to gather momentum.